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‘Independent ideas generate independent returns’

Investors should focus on the fundamental investment thesis of a fund and avoid idea concentration, over-reliance on correlation and discounting of tail events when accounting for market cycles, IPM chief executive Stefan Nydahl has said.

Nydahl spoke at the Investment Magazine Absolute Returns Conference and was strongly in favour of establishing processes and products based on sound fundamentals, because behavioural biases can create fundamental dislocations. He cited a quote from a 1954 paper by Harry Markowitz as a touchstone for the session.

“A good portfolio is more than a long list of good stocks and bonds, it’s a balanced whole, providing investors protections and opportunities with respect to a wide range of contingencies,” Nydahl said. “That about sums it up, right? That’s what we’re trying to do.

“Now, it seems like over the last 10-15 years, looking at it from the sidelines, we’re running a hedge fund, but people tend to forget about these insights from Harry. One of the reasons is that who needs more when you have a market like we’ve had the last 10-15 years.”

Nydahl noted that the current negative correlation between equities and bond returns that has led to specific investment decisions and products is, in fact, atypical. He pointed to macroeconomic market data from the Bank of England from the 1700s to now, and found that the equity/bond correlation for the UK markets demonstrates that the only other time in that 300-plus year history that had a similar negative correlation was “the depression in the 1860s”, thus fund managers shouldn’t count on the negative correlation continuing.

Nydahl also noted that seeking out new correlation patterns might find valid theories but could also result in invalid ones, while “diversification is not easily achieved”. He also suggested that more thought should be devoted to planning for extreme “tail events” and that the foundation for investments is ideas.

“The building block of what we do is the ideas,” he said. “This is not a bad place to start if you look at creating independent returns. Independent ideas will generate independent returns.

“If you want to diversify investment ideas, and I think this is true for asset allocators, asset managers, you have to realise that idea concentration can result in very poor diversification. It’s easy to forget that sometimes, when you have a broad portfolio. You can have 500 assets in my portfolio. Well, if they all come from the same idea, or if you have a manager that claims that he’s diversified [but all the assets come from the same idea], it’s not much diversification.”

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